How China reclaimed its title as largest holder of Treasurys

China holdings of U.S. government paper up more than $44 billion in June, the biggest monthly jump in six years

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The People's Bank of China in Beijing.

By

SunnyOh

China is once again the U.S.’s biggest creditor thanks to its efforts to stabilize the currency.

The yuan’s
USDCNY, +0.0058%
strengthening against the dollar in the past three months has helped China, the world’s second-largest economy, reclaim its spot as the no.1 holder of Treasurys in June after an eight-month hiatus, relegating Japan to second place. The dollar bought 6.68 yuan on Wednesday trade after having hovered at levels of 6.90 yuan back in May.

China’s holdings of U.S. government paper rose to $1.147 trillion in June, up more than $44 billion from the previous month. This represents the largest monthly gain in six years. Meanwhile, Japan’s holdings slipped $20.5 billion to $1.09 trillion, according to data from the Treasury International Capitol system on Tuesday.

The strengthening currency, along with its status as a major exporter, has helped boost China’s trade surplus. This can lead to a rapid accumulation of Treasurys, as a burgeoning trade surplus has to be balanced with Beijing raising the size of its cross-border investments.

Credit: Capital Economic, Thomson Reuters

China is re-building its hoard of Treasurys

The report comes on the heels of the Communist Party’s efforts to steady the currency ahead of its once-every-five-years leadership shuffle that could prove pivotal to how Chinese economic policy evolves. Minimizing market turmoil could serve as “window-dressing” for the occasion, said Tim Alt, fund manager of rates & currencies at Aviva Investors. To do this, the central bank has intensified its protracted battle against speculators shorting the yuan.

“In light of the upcoming Party Congress and the ongoing U.S.-China trade negotiations, we would expect the authorities to push back against any significant idiosyncratic depreciation pressure on [the Chinese yuan] in the next couple of months,” said Goldman currency strategists in a note published on Aug. 16.

Moreover, Beijing is cracking down on outbound mergers and acquisition this year. Chinese companies engaged in more than $200 billion worth of deals in 2016, an all-time record, data from Dealogic shows. Some economists have suggested the blockbuster deals are a way of circumventing strict regulations on capital flight.

In response, Chinese authorities has detained one of the more prominent wheeler-dealers, Anbang Insurance’s President Wuxiao Hui, who has had held failed talks with President Donald Trump’s son-in-law Jared Kushner for a potential real estate sale in New York City.

“All signs point to a deceleration of the three-year run for China outbound M&A into the U.S.,” said analysts from Dealogic.

All these factors have helped turn the stream of money escaping the country into a more modest trickle, lifting the downward pressure on the yuan. Net foreign exchange flows out of China slipped to $14 billion in July, according to data from Goldman Sachs (see chart below). Since February, outflows have fallen below $25 billion for six consecutive months, a sharp contrast from 2016, when the monthly readings regularly topped $50 billion.

Credit: Goldman Sachs Global Investment Research

China’s authorities have successfully stemmed money flows out of the country.

All credit, however, shouldn’t rest with China’s technocrats, who have regularly interfered in their own financial markets. The dollar’s steady descent as Trump’s pro-growth agenda is put on the backburner has given a boost to all currencies against the buck, not just the yuan. The ICE dollar index
DXY, +0.37%
, which measures the greenback against six major currencies, has plummeted more than 8% year-to-date.

But what does this mean for investors? Purchases of Treasurys from China are closely watched by bond traders as analysts suspect large foreign investors like China have kept a lid on yields for U.S. government paper, despite the Fed being on track to raise rates a few more times by the end of next year.

The bump in China’s total holdings coincided with anecdotal reports that the country was returning back to its role as a key player in the U.S. bond market as the summer began, said Thomas Simons, senior money market economist for Jefferies.

He suggested the relatively strong performance of Treasurys sporting extended maturities since June could be tied to Chinese bond buyers, who prefer to snap up longer-dated sovereign debt.

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